Most anyone reading this will know that last week was a miserable one for stocks.
What they might not realize is just how bad it was.
For perspective, last week’s 3.1% loss was the biggest weekly setback the Nasdaq Composite has seen since June 2012. Even more troubling is that last week’s pullback was the third losing week in a row for the Nasdaq, forcing investors to wonder whether this is the onset of the big correction that we’ve managed to sidestep for more than two years now.
Well … it actually might be the beginning of a sizable pullback. Maybe even a full-blown correction. But before anyone with a stake in the stock market jumps to a conclusion about how big and red a flag this all is, they need to take a step back, take a deep breath and digest the following four realities:
#1: The Nasdaq Still Has an Escape Hatch…
As nasty as the selloff has been since the March 7 peak, the Nasdaq still hasn’t broken under a key support level at 3967 (give or take). That was where the composite bounced in early February and in mid-December. That level also was a ceiling for a short while in October.
While prior floors and ceilings don’t always act as floors and ceilings in the future, this is a line that more than a few traders are watching. Ergo, it’s a level that many traders might treat as a pivotal level, which means — even if only for psychological reasons — it is a pivotal level that could end up stopping the pullback and jump-starting a reversal.
#2: …But the S&P 500 Doesn’t Have an Escape Hatch
The quintessential large-cap index hasn’t exactly been taken to new multimonth lows yet, but its best shot at a quick end to the selloff — the floor at 1841 — was taken out Thursday. The S&P 500 put some distance between itself and that support level on Friday.
The next logical floor is February’s low of 1737.92, but if the S&P 500 falls all the way to that level, that’s going to be a correction of more than 8% from the April 4 peak. If the market is allowed to fall that far, odds are good that investors will be spooked enough by that point to let it keep sliding.
#3: It Has Been Two-and-a-Half Years Since a Major Correction
“Major correction” simply means a pullback of 10% or more from high to low. Truth be told, we’ve seen uninterrupted rallies last much longer than this one has. The early-2003-to-late-2007 rally, for instance, remained in motion for 57 months before the subprime crisis tripped it up. The current one is only 30 months old, and has only doled out a 68% advance from low to high vs. a 90% gain for the 2003-07 move.
If you do the math, though, this one has run at a much hotter pace than the prior run-up did. You can only keep the pedal to the metal for so long before burning up the engine, and we might well be at that point.
#4: This (Still) Has Nothing to Do With Value
Despite what some of the media’s favorite analysts and gurus are suggesting, the market’s underlying fundamentals are fine. They’re not great, but they’re OK.
As of Friday, the S&P 500′s trailing P/E ratio is 16.7, and the forward-looking P/E ratio is a plausible 14.7. The market is supposed to grow earnings to the tune of 13% over the coming four quarters. Nothing that has happened within the past week truly jeopardizes that growth.
This dip is little more than a market that got caught off guard in just the right way once traders realized how much we’ve rallied since September 2011.
Of the four takeaways, the fourth one is the most important, but the third one is almost as crucial to embrace. The market still has more upside to offer long-term investors than not, though we are getting to the point (well, we’re at the point, and perhaps even past the point) where the market’s long-unchecked rally is starting to struggle under the weight of its own gains.
While it seems terrifying in the moment — and it could get worse before it gets better — in the grand scheme of things, even if the worst-case scenario materializes and we do see a correction, it will be a fading memory within a few months.
You just need to decide whether you’re viewing this corrective action from an investor’s point of view, or a trader’s point of view.